The Costs and Benefits of Supply Chain Liability

Supply chain liability has become a critical concept in the modern global economy. In particular, under frameworks such as the European Union’s Corporate Sustainability Due Diligence Directive (CSDDD), there are increasing efforts to hold multinational corporations accountable for human rights abuses and environmental damage, even when caused by subsidiaries or independent business partners. My recent paper, ’An Economic Analysis of Supply Chain Liability’, provides a thorough examination of this concept, highlighting both its economic rationale and the potential risks and benefits associated with its implementation.

The growing attention to supply chain liability stems from the recognition that many of the world’s most pressing social and environmental issues are linked to the operations of multinational corporations and their complex web of suppliers. The global nature of these supply chains often leads to situations where violations of human rights or environmental standards occur in countries with weaker regulatory frameworks. In response, legislators and regulators in various countries, particularly in Europe, have begun to develop laws and regulations that extend the liability of multinational corporations beyond their direct actions to include those of their subsidiaries and independent business partners.

From an economic perspective, the justification for supply chain liability hinges on the idea of under-deterrence. In many cases, suppliers—particularly those in less developed regions—may not be sufficiently deterred by the threat of direct liability due to factors such as limited financial resources, inadequate information, or weak enforcement of laws. As a result, these suppliers may fail to take adequate measures to prevent harm such as environmental degradation or human rights abuses. When direct liability fails to incentivize proper behaviour, extending liability to the lead companies in the supply chain can create stronger incentives for harm prevention.

The paper makes a crucial distinction between subsidiaries and independent business partners in the context of supply chain liability. Subsidiaries are controlled by the parent company and therefore their actions are easier to influence. This may justify holding parent companies strictly liable for any harm caused by their subsidiaries. Strict liability would ensure that the parent company cannot evade responsibility by using the subsidiary as a liability shield. On the other hand, independent business partners, over whom the relevant multinational corporation has less control, should be subject to negligence-based liability. This means that the multinational would only be held liable if it fails to exercise due diligence in supervising or controlling the actions of its independent business partners.

One of the key economic arguments in favour of supply chain liability is that it encourages multinational corporations to implement effective due diligence measures throughout their supply chains. This can include monitoring and influencing the behaviour of suppliers, ensuring that they adhere to acceptable standards, and taking corrective action where necessary. By doing so, the lead companies in global supply chains internalise the costs associated with human rights abuses and environmental harm that might otherwise fall on society or the victims themselves.

However, the paper also acknowledges the potential risks and side effects of supply chain liability. One significant concern is the possibility of an inefficient multiplication of due diligence efforts. If multiple entities within the same supply chain are incentivized to conduct overlapping monitoring and control activities, this could lead to increased costs without a corresponding increase in harm prevention. The same applies to supply chains that partially overlap. The increasing prevalence of supply chain liability could also create a situation where lead companies, in an attempt to avoid liability, engage in evasive behaviour, such as restructuring their supply chains.

Another risk highlighted in the paper is the potential for supply chain liability to contribute to the de-globalisation of supply chains and a move away from regions where business operations are difficult and costly to monitor. Companies may decide to withdraw from certain regions or reduce their international operations due to the perceived risks and complexities associated with complying with stringent monitoring and liability rules. This could lead to inefficiencies in the global division of labour, ultimately harming both businesses and the communities that rely on them.

The paper advocates for a balanced approach to supply chain liability, one that carefully considers the specific circumstances of each case. While extending liability to lead companies in supply chains can be an effective tool for promoting due diligence and preventing harm, it is crucial to design these liability regimes in a way that avoids unintended consequences. In addition to considering the type of relationship between the lead company and the supplier, the paper also suggests that policymakers should take the specific risks associated with different types of harm into account. For example, the risks associated with human rights violations may require different regulatory approaches compared to environmental harms. Moreover, the paper questions whether it is necessary to incur the considerable reputational risks and costs associated with legislative frameworks that focus primarily on human rights and environmental damage. The financial risk to companies from the public outrage that ensues human rights abuse and environmental disasters will often be many times higher than the damage caused to victims and public goods. This will not always be beneficial for victims, because companies have particularly strong incentives not to acknowledge responsibility.

In conclusion, supply chain liability represents a critical mechanism for ensuring that multinational companies take responsibility for the broader impacts of their global operations. By creating incentives for lead companies to monitor and influence the behaviour of their suppliers, supply chain liability can help address the under-deterrence problem that often plagues global supply chains. However, the implementation of such liability must be approached with caution to avoid creating inefficiencies or discouraging beneficial economic activities. A well-designed liability regime that takes the specific circumstances of each case into account can help ensure that supply chain liability achieves its intended goals of preventing harm and promoting sustainable business practices.

The full article can be accessed here.

Carsten König is Post-doc Researcher and Lecturer at the University of Cologne, Germany.